The danger of forced liquidation in crypto margin trading

Cryptocurrency volatility is a double-edged sword. On one hand, sharp price movements create profitable opportunities. On the other hand, they carry serious risks, especially for those trading with leverage. One of the main threats of such trading is liquidation of positions. This mechanism automatically closes a trader’s deals when the market moves against them, often leading to significant losses.

Why Traders Take on the Risk of Borrowed Funds

Leverage attracts crypto traders with simple math: investing $100 with 10x leverage allows controlling a position of $1,000. Even a small price increase yields substantial profit. The exchange provides these funds in exchange for collateral — your initial margin.

However, this logic only works under favorable conditions. Any unexpected price movement in the opposite direction quickly eats into the margin. And here, the main enemy of risky positions comes into play — liquidation.

How the Forced Closure Mechanism Works

Liquidation is not just closing a position. It is an automatic action performed by the exchange when your collateral becomes insufficient to maintain the open trade. The process begins with a margin call — a requirement to deposit additional funds.

At this stage, the trader has a window of opportunity: they can top up the account, close part of the position, or accept losses and exit voluntarily. But if nothing is done, the exchange intervenes automatically. It forcibly liquidates the position at the current market price — often at a worse price due to slippage.

The exchange charges a fee for this service. Thus, it incentivizes traders to manage risks themselves rather than rely on automatic closure.

Understanding the Liquidation Level

Every leveraged position has a critical price — the level at which liquidation occurs. This level is calculated based on the leverage size, the current asset price, the account margin size, and the required maintenance margin percentage.

The key point: this level is not fixed. It changes depending on price fluctuations and your balance. Traders must always know where their liquidation level is to anticipate the worst-case scenario.

Two Scenarios of Liquidation

Partial liquidation occurs when only part of the position is closed. This is usually a voluntary action by the trader aimed at reducing risks. Thus, the investor can save part of their funds and continue trading.

Full liquidation is a more serious event. The exchange sells all assets from the position to cover losses. It is almost always a forced event that occurs after the trader ignores the margin call. In critical situations, liquidation can lead to a negative balance. Here, the exchange’s insurance funds come into play, covering such losses and protecting other market participants.

Effective Protection Against Liquidation

The first rule of risk management is to determine the amount of loss you are willing to tolerate. Professional traders limit risk to 1–3% of their balance per trade. This means that even with 100 consecutive losing trades, the account will not be completely depleted. Such a scenario is practically impossible in the crypto industry.

The second, equally important rule — always use stop-loss orders. Setting a stop 2% below the entry price limits the loss to a manageable amount. When the market moves quickly, the stop-loss triggers automatically, preventing the position from sliding to the liquidation level.

Emotional control complements these mechanical tools. The cryptocurrency market can change direction within minutes. Without a clear plan and pre-set exit levels, it’s easy to lose the opportunity to close a position safely.

Why Liquidation Is an Inevitable Risk of Margin Trading

No calculation can fully protect against liquidation in conditions of extreme volatility. Such guarantees do not exist. But the risk can be significantly reduced through discipline and proper position management.

Remember: closing a losing position quickly by yourself is always better than forced liquidation initiated by the exchange. The former saves on fees and allows preserving part of the capital for future trades.

Answers to Key Questions

What happens during liquidation in crypto?
The exchange automatically sells your position to cover losses when margin becomes insufficient.

Which liquidation is the most dangerous?
Full liquidation, where all assets are sold and a negative balance may occur.

How to minimize risk?
Limit risk to 1–3% of your balance per trade and set a stop-loss on each position.

Does liquidation differ for different assets?
The mechanism is the same, but volatile assets like Bitcoin carry a higher risk of liquidation due to frequent sharp price jumps.